Best possible deal IMF

VIAAnjum Ibrahim
SOURCEBusiness Recorder
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Did Hafeez Sheikh get the best possible deal from the International Monetary Fund (IMF) given Pakistan’s unsustainable twin deficits, budget deficit estimated at 7.2 percent of GDP (though independent sources place it nearer to 8 percent) and a declining current account deficit of 9.58 billion dollars for the first nine months of the year (against 13.589 billion dollars in the comparable period last year)?

To assess Sheikh’s performance there are two available sources of information. One source, Hafeez Sheikh himself; his two interactions with the media were carefully calibrated – one on the state-run television where he announced the staff level agreement with the IMF and the other while addressing a press conference on the amnesty scheme with other members of the federal cabinet.

The second source is the IMF mission that did not take any questions from the media but uploaded a press release on the agreement on its website. The entire agreement will be uploaded only after the loan is approved by its Board of Directors which is not expected till after Pakistan meets the extremely challenging “prior” conditions. The press release specifies ‘prior’ conditions but Wednesday’s action by the State Bank of Pakistan (SBP) to allow a market determined exchange rate (with the monetary policy board meeting to take place today, brought forward by 11 days, expected to raise rates as per the agreement), and raising gas prices by 45 percent Friday indicates that not all ‘prior’ conditions have been clearly identified.


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Dr Hafeez Sheikh during his appearance on the state television did not give any details of the agreement and, instead, followed a pattern associated with politicians rather than technocrats: denigrate the performance of previous administrations followed by defending the agreement by maintaining that many of the IMF conditions are in Pakistan’s interests particularly with respect to spending according to our means (read: bringing the deficit to a sustainable level though he failed to mention by how much and what it would entail), improving the performance and governance of state owned entities (read: privatization which has been fiercely resisted by the unions compelling previous administrations to abandon it), targeting subsidies, making the rich pay more taxes and full cost recovery of utility companies through passing the burden onto consumers including industry which would no longer receive concessionary tariffs.

The poor defined as those using 300 units of electricity or less every month would not be affected by a raise in electricity rates; and benefit from an expanded social protection programme for 2019-20, envisaging 180 billion rupee allocation already announced by the Prime Minister before Sheikh was gifted the portfolio – 80 billion rupees more than spent this year or such is the claim. And Sheikh pledged an allocation of 800 billion rupees for Public Sector Development Programme (PSDP) in 2019-20. In this context it is relevant to note that the PML-N April 2018 budget also envisaged 800 billion rupees on PSDP (doable as the previous year it had disbursed 750 billion rupees for the purpose) and 180 billion rupees on development expenditure outside PSDP (including Benazir Income Support Programme).

The IMF press release, in spite of its brevity, however provides more specifics, which are highly disturbing. Pakistani negotiators bafflingly agreed to a market determined exchange rate, implying that the SBP would no longer provide an indicative level to banks’ treasuries within which the rupee dollar parity would be free to fluctuate though it would watch carefully that there is no attempt to squeeze the market; as opposed to free float, which is defined as the foreign exchange market determining the currency value according to supply and demand. The IMF press release does not specify this as a prior condition however SBP began allowing a market determined rate on Wednesday and by Friday the interbank rate dropped from 141.5 to 148.5 adding 661 billion rupees to the country’s debt as each rupee depreciation vis a vis the dollar adds 105 billion rupees to debt.

As per IMF’s 2014 study 82 countries use a managed float or 43 percent of all countries. Pakistan has a high liability of dollarization and financial fragility to boot – conditions that militate against supporting a market determined rate. One would have hoped that Sheikh had convinced the Fund to defer this condition for later in the programme, preferably year two, when the economy had stabilized to some extent.

An eroding rupee will make the target of bringing the primary deficit (defined as fiscal deficit minus interest payable on previous borrowings), an indicator of whether the government is falling into a debt trap, from the existing 1.9 percent of GDP (independent economists estimate it at 2.1 to 2.2 percent) to 0.6 percent even more challenging. To achieve this target implies raising revenue and reducing expenditure and the IMF press release spells out what Sheikh agreed to on behalf of the country. Revenue is to be raised through eliminating exemptions, curtailing special treatments and improving tax administration. These measures would effectively make the export promotion and industrial promotion package (part of the second amendment finance bill 2019) redundant. Facilitating trade is cited as one of the priority areas but exports are likely to stagnate as fiscal incentives are eliminated so perhaps facilitation implies removing fiscal barriers to imports (which may undermine the effect of a depreciating rupee discouraging imports to the level envisaged). These measures would result in a lower growth rate and, as a consequence, lower employment opportunities.

Prudent expenditure growth, the Fund states, would be aimed at preserving essential development spending scaling up the Benazir Income Support Programme (and/or the Ehsaas Programme) and improve target subsidies. That leaves current expenditure where the axe would fall to achieve 0.6 percent primary deficit target.

While holding no brief with previous governments slashing development expenditure to meet the budget deficit targets and allowing current expenditure to increase from the amount budgeted yet it is relevant to note the implications of what Sheikh signed of on. The major recipients of current expenditure which accounted for 85 percent of its allocations in 2017-18 are: (i) interest and repayment of debt as and when due – an allocation that cannot be reduced without the government defaulting; this accounted for around 45 percent of current expenditure in 2017-18 and this year with continued depreciation the percentage allocation would be much higher; (ii) defence accounted for 23 percent; (iii) pension (civilian and military) accounted for 8 percent which cannot be slashed; and (iv) running of civilian government 9.3 percent. The only items that can and would therefore have to be adjusted are defense and civilian administration (which is probably why Younus Dagha, Secretary Finance, was given his walking papers during the final days of the negotiations). It is unclear whether Hafeez Sheikh has highlighted this to the Prime Minister as well as these two powerful institutions before reaching an agreement with the IMF.

IMF projected a growth of 2.9 percent for the current fiscal year and a further decline to 2.8 percent next fiscal year, if policies continue – an assessment before the staff level agreement was reached. By agreeing to a 0.6 percent of GDP primary deficit Hafeez Sheikh’s gift to the nation would be bringing the growth rate for next fiscal year down by at least one percentage point. In evaluating Sheikh’s performance the Prime Minister must be wary of his penchant for data manipulation that he exhibited during his previous stint as the finance minister – changing the weightage of components of Consumer Price Index which led to a rate 12 percentage points lower.

The IMF press release refers to confirmation of international partners’ financial commitments as a prior condition, the first time in the history of Pakistan’s engagement with the Fund and perhaps the first time in the Fund’s history. The reason 12 billion dollars, as per Hafeez Sheikh, is the shortfall in meeting our obligations next year and the sources so far identified are: 6 billion dollars from the IMF for 39 months with a maximum of 3 billion dollars in the first year (though this too would not reflect the norm); if the World Bank and ADB extend 2 to 3 billion dollars then the maximum for next year would be no more than 1.5 billion dollars. What the Fund maybe requiring as a ‘prior’ condition is a commitment from the three “friendly” countries to roll over the 9.4 billion dollar one year loan which becomes due next year though for how long is not specified: 3 billion dollars from Saudi Arabia, 2 billion dollars from United Arab Emirates with another billion pledged and 4.4 billion dollars from China.

And finally Sheikh would have agreed to provide the Fund staff with details of all loans acquired, particularly those under the China Pakistan Economic Corridor, in response to a concern first voiced by US Secretary of State Mike Pompeo and echoed in more diplomatic parlance by the IMF Managing Director last year.

Narrowing of trade deficit

Dr Hafeez Sheikh has acquired the bailout package, his only claim to success, but then anyone would have been able to acquire a package which accepted the IMF conditions in full. The cost of the package is untenable not only for the people of this country but also for powerful institutions in the country. Ironically one can only rely on his predecessor Asad Umer who has assumed the position of chairman of the standing committee on finance to not only query Sheikh on the details of the staff level agreement but, as a long term committed PTI member, to look at it from the perspective of his party’s pledges and bring it to the notice of the Prime Minister and the people of this country.

To conclude, the options before the government are very limited. There is a need for out of the box independent thinking that his current team simply does not have the capacity to, based on its experience. Imran Khan needs economists, academicians, and needs to lure the three Pakistani economists working abroad in institutions where independent research is carried out – men that he originally wanted on his team but abandoned the idea for sectarian reasons.

(This news/article originally appeared in Business Recorder on May 20th, 2019)

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